NOTE 13 — INCOME TAXES

The components of the provision for income taxes were as follows:

 

(In millions)
Year Ended June 30,		2014				2013				2012
Current Taxes
U.S. federal		$	3,738			$	3,131			$	2,235
U.S. state and local			266				332				153
Foreign			2,073				1,745				1,947
Current taxes			6,077				5,208				4,335
Deferred Taxes
Deferred taxes			(331	)			(19	)			954
Provision for income taxes		$	5,746			$	5,189			$	5,289

U.S. and foreign components of income before income taxes were as follows:

 

(In millions)
Year Ended June 30,		2014				2013				2012
U.S.		$	7,127			$	6,674			$	1,600
Foreign			20,693				20,378				20,667
Income before income taxes		$	27,820			$	27,052			$	22,267

The items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows:

 

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Year Ended June 30,		2014				2013				2012
Federal statutory rate			35.0%				35.0%				35.0%
Effect of:
Foreign earnings taxed at lower rates			(17.1)%				(17.5)%				(21.1)%
Goodwill impairment			0%				0%				9.7%
Other reconciling items, net			2.8%				1.7%				0.2%
Effective rate			20.7%				19.2%				23.8%

The reduction from the federal statutory rate from foreign earnings taxed at lower rates results from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. Our foreign earnings, which are taxed at rates lower than the U.S. rate and are generated from our regional operating centers, were 81%, 79%, and 79% of our foreign income before tax in fiscal years 2014, 2013, and 2012, respectively. In general, other reconciling items consist of interest, adjustments for intercompany transfer pricing, U.S. state income taxes, domestic production deductions, and credits. In fiscal years 2014, 2013, and 2012, there were no individually significant other reconciling items.

The components of the deferred income tax assets and liabilities were as follows:

 

(In millions)
June 30,		2014				2013
Deferred Income Tax Assets
Stock-based compensation expense		$	903			$	888
Other expense items			1,112				917
Unearned revenue			520				445
Impaired investments			209				246
Loss carryforwards			922				715
Other revenue items			64				55
Deferred income tax assets		$	3,730			$	3,266
Less valuation allowance			(903	)			(579	)
Deferred income tax assets, net of valuation allowance		$	2,827			$	2,687
Deferred Income Tax Liabilities
Foreign earnings		$	(1,140	)		$	(1,146	)
Unrealized gain on investments			(1,911	)			(1,012	)
Depreciation and amortization			(470	)			(604	)
Other			(87	)			(2	)
Deferred income tax liabilities		$	(3,608	)		$	(2,764	)
Net deferred income tax assets (liabilities)		$	(781	)		$	(77	)
Reported As
Current deferred income tax assets		$	1,941			$	1,632
Other current liabilities			(125	)			0
Other long-term assets			131				0
Long-term deferred income tax liabilities			(2,728	)			(1,709	)
Net deferred income tax assets (liabilities)		$	(781	)		$	(77	)

As of June 30, 2014, we had net operating loss carryforwards of $3.6 billion, including $2.2 billion of foreign net operating loss carryforwards acquired through our acquisition of Skype, and $545 million through our acquisition of NDS. The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized.

Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are actually paid or recovered.

As of June 30, 2014, we have not provided deferred U.S. income taxes or foreign withholding taxes on temporary differences of approximately $92.9 billion resulting from earnings for certain non-U.S. subsidiaries which are permanently reinvested outside the U.S. The unrecognized deferred tax liability associated with these temporary differences was approximately $29.6 billion at June 30, 2014.

Income taxes paid were $5.5 billion, $3.9 billion, and $3.5 billion in fiscal years 2014, 2013, and 2012, respectively.

 

Uncertain Tax Positions

Unrecognized tax benefits as of June 30, 2014, 2013, and 2012, were $8.7 billion, $8.6 billion, and $7.2 billion, respectively. If recognized, these tax benefits would affect our effective tax rates for fiscal years 2014, 2013, and 2012, by $7.0 billion, $6.5 billion, and $6.2 billion, respectively.

As of June 30, 2014, 2013, and 2012, we had accrued interest expense related to uncertain tax positions of $1.5 billion, $1.3 billion, and $939 million, respectively, net of federal income tax benefits. Interest expense on unrecognized tax benefits was $235 million, $400 million, and $154 million in fiscal years 2014, 2013, and 2012, respectively.

The aggregate changes in the balance of unrecognized tax benefits were as follows:

 

(In millions)
Year Ended June 30,		2014				2013				2012
Balance, beginning of year		$	8,648			$	7,202			$	6,935
Decreases related to settlements			(583	)			(30	)			(16	)
Increases for tax positions related to the current year			566				612				481
Increases for tax positions related to prior years			217				931				118
Decreases for tax positions related to prior years			(95	)			(65	)			(292	)
Decreases due to lapsed statutes of limitations			(39	)			(2	)			(24	)
Balance, end of year		$	8,714			$	8,648			$	7,202

During the third quarter of fiscal year 2011, we reached a settlement of a portion of an I.R.S. audit of tax years 2004 to 2006, which reduced our income tax expense by $461 million. While we settled a portion of the I.R.S. audit, we remain under audit for these years. In February 2012, the I.R.S. withdrew its 2011 Revenue Agents Report and reopened the audit phase of the examination. As of June 30, 2014, the primary unresolved issue relates to transfer pricing, which could have a significant impact on our consolidated financial statements if not resolved favorably. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months. We also continue to be subject to examination by the I.R.S. for tax years 2007 to 2013.

We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2013, some of which are currently under audit by local tax authorities. The resolutions of these audits are not expected to be material to our consolidated financial statements.